Behind Closed Doors

Known for being press shy, unlike some hedge fund managers, Paul Tudor Jones broke onto the trading scene with a splash by calling the 1987 stock market crash just days before it happened. So it was big news this week when it was revealed that Paul Tudor Jones, at a closed door meeting this week at Goldman Sachs, said that the Federal Reserve should be freaked out by this one “terrifying chart”. The chart in question also happens to be Warren Buffett’s primary indicator of market valuations.

It makes for good headlines but we have to say we have followed this chart for years and it is not a very good timing indicator for market corrections. However, it is a very good guide to the valuation of the overall market here in the Unites States and it is quite high. Market s can stay irrational longer than you can remain solvent betting against them. Interest rates and ballooning central bank balance sheets have pushed asset prices around the world to new heights.

It remains to be considered that IF central banks ever stop buying or, god forbid sell, then markets should fall. More interestingly, Jones said that the catalyst to the market fall will be risk parity funds. A bit inside baseball but, basically, the explosion of risk parity funds is based on momentum. The lower the market goes the more risk parity funds will have to sell equities. It could exacerbate any run in the market just as it has on the upside. :

We have been weighing in on the active vs. passive debate in the last few weeks as we feel that we have reached an inflection point. We believe that the pendulum swings back when it reaches extremes and we believe that we may be at that point. Think of it like this.  If everyone is invested 100% in ETF’s, passive management, then wouldn’t it be prudent to employ an active allocation to try and capture what inefficiencies are created by blindly piling en masse into ETF’s. We have been vocal proponents of the benefits of passive management but the pendulum may have swung too far and more evidence, however anecdotal, was presented this week by the creation of an ETF for ETF’s. An exchange traded fund (ETF) was created this week to follow the companies that benefit from the growth in the ETF industry. Maybe sometimes they do ring a bell. Time for more research.

Congress has been closed so the Trump Reflation obsession was put on hold and investors and media grew obsessed with geopolitical concerns with a spotlight on the French elections and North Korea.  Rates are falling while gold is rising. Fear is rising as some are reaching for protection in what is known as the “fear trade”. A move to gold and US Treasuries is the usually accompaniment when fear rises, especially in light of geopolitical concerns. Investors have become a bit more defensive. We may see rates rise and gold fall when Congress gets back into session.

Last 30 minutes of trading thesis has been inconclusive so far. No definitive pattern yet. Market seems to be in a consolidation pattern. The market seems to be digesting its gains and gathering itself before a move to a higher summit. Markets do not top out like this – spending weeks at a given level. The odds are that markets, when leaving a consolidation phase, move in the direction in which they came in.

I  think we aspire less to foresee the future and more to be a great contingency planner… you can respond very fast to what’s happening because you thought through all the possibilities, – Lloyd  Blankfein

To learn more about us and Blackthorn Asset Management LLC visit our website at www.BlackthornAsset.com .

A pessimist sees the difficulty in every opportunity; an optimist sees the opportunity in every difficulty. – Winston Churchill

Disclosure: This blog is informational and is not a recommendation to buy or sell anything. If you are thinking about investing consider the risk. Everyone’s financial situation is different. Consult your financial advisor.

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Published in: on April 22, 2017 at 6:31 am  Leave a Comment  
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Roller Coaster Markets

Be fearful when others are greedy and greedy when others are fearful. – Warren Buffett

Well, that was some beginning to 2016! We knew that volatility was coming our way but we did not foresee what happened in Q1. The Dow Jones managed to complete a round trip ticket as we fell 13% and subsequently rose back up 13% in one quarter. That is the biggest intra quarter comeback since the middle of the Great Depression in 1933. Our portfolio strategy coming into 2016 was to tactically manage our asset allocations given that we expected higher volatility and lower returns. Although we didn’t see a round trip in the offing for Q1 of 2016 our strategy worked out quite well. We believe that the rest of 2016 has much the same in store as the market reacts to every nuance emanating from the Eccles Building in Washington DC which is the home of the Federal Reserve Bank of the United States.

We believe that risks are rising after our second 12% rally in months. We have elevated valuations and falling earnings estimates for US companies. It is going to be difficult for the stock market to move higher from here but we cannot bet against continued central bank largesse. The stock market, having rallied 13% off of its recent lows in early February reminds us of a blog post from back in October of 2015. This is what we had to say back in October.

October 2015 will go down as the best performing month for the S&P 500 in four years.  I think that we all enjoyed the ride back up in October. The S&P 500 rallied 8.3% and followed through with more gains today to get the S&P 500 into the plus column for 2015. Those gains would be nice gains for an entire year – never mind a month! Whenever we get to thinking how much we have gained we cannot help but to contemplate the downside. We must always be on guard to temper our greed/ego just as much as we would concentrate on opportunity when fear strikes.

As a reminder, the volatility continued then as well. The S&P 500 closed October of 2015 at 2080. It would be 10% lower by January of 2016.

The key to making money in your portfolio lies in Investor Psychology. Understanding investor psychology and our own personal relationship with money is the key to successful investing.  Having just ridden the roller coaster of emotions that was Q1 we are in a good position to replay how the highs and lows of the market made us feel and how we reacted to it. The two following charts can help you be more successful in understanding how emotions play a role in your investing process.  The first shows two 12% rallies in the last 7 months. The second is a chart of investor psychology. After our second 12% rally in 7 months we should revisit how that roller coaster made us feel. Were you despondent at the lows? Did it make you want to sell and get out or buy more? Are you now relieved? Optimistic? Are you aching to buy more as prices rise?

dow chart 2 12pct rallies 2016

 

psy-cycle

 

In order to be on the right side of the market it is important to sell risk when prices are rising and buy risk when prices are falling. Or in emotional terms, when prices are falling and you are scared ask yourself “What should I be buying”? When prices are rising, ask, what are we selling? Understanding and keeping your emotions in check is the key to making money in markets like these. Ride the roller coaster.

 Valuations

For long time readers and clients you know that one of our favorite metrics of stock market valuation is the US Stock Market Capitalization to GDP. It also happens to be Warren Buffett’s favorite metric in case you wonder why we follow it as well. As you can see from the following chart courtesy of Ned Davis Research the last time that the Stock Market Capitalization as a percentage of GDP was in an undervalued position was in July of 1982.

Ned Davis March 2016 Mkt Cap GDP

What changed since the early ’80’s? Central banks gained enormous influence over markets when President Richard Nixon took the United States off of the Gold Standard. This allowed central banks to help manage booms and busts in the economy without being hamstrung by the amount of gold in Fort Knox. Theoretically, they now had an unlimited supply of gold with printed fiat money taking the place of gold. This was the dawn of the Golden Age of Central Banking. The Prime Interest rate from the Federal Reserve reached its high of 21.5% in June of 1982. We have had a steady trend of lower interest rates for the last 30+ years.

Since 1995 (with the exception of February 2009) we have been in the overvalued area of the chart. This chart is evidence of the inexorable influence of central banks on asset prices. Some questions remain. Are we in a permanent state of overvaluation due to the influence of central bankers? If that state of overvaluation is not permanent at what point does central bank influence wane and valuations retreat to historical levels. Also, if central bankers remain in control of markets how low will central bankers allow markets to descend? Given our current inflated valuations we know that based on history we can expect lower returns over the next 10 year time frame.

Another natural question is posed if we feel that returns are to be muted or that prices should retreat. Why not sell out of all our assets and wait things out in cash? I think that the chart also answers that question. We have been in a perpetual state of overvaluation since 1995 – over twenty years!  In order to meet our investing goals we cannot afford to sit out markets until they become more rationally priced. There is also the distinct possibility that markets become even more overpriced. If inflation were to take hold here in the United States investors would want tangible assets that rise in value with inflation. Equity prices could become wildly overpriced.  John Maynard Keynes, the legendary economist once said, “markets can stay irrational longer than one can remain insolvent” betting against them.

We know that it has been a goal of central banks since the dawn of the crisis in 2008 to raise asset prices and therefore raise confidence in the economy but they are now distorting price discovery with monetary policy. This extreme action taken by central banks takes away some of our normal techniques for evaluating markets as markets are warped by policy.

Less Gas in the Tank

Unfortunately, the Federal Reserve has recently discovered with its latest interest rate hike that they are now the WORLD’s central bank and its moves have outsized effects on the rest of the world.  Central banks can pull future returns forward and stall for time so that legislators can enact fiscal policy with which to mend an ailing economy. However, due to reluctance or ineptitude legislators have done nothing and left central banks, and in particular, the US Federal Reserve as the only game in town. If the Federal Reserve raises rates it then weakens other currencies and encourages capital flight. Capital goes where it is treated best. Higher rates of interest in the US and a stronger US Dollar force money to quickly flood out of emerging nations and into the United States. Central banks are stalling for time and currency wars are de rigueur. We have entered a “Twilight Zone” of monetary policy with negative interest rates in Europe and Japan. Central bank officials are also faced with the fact that monetary policy is not immune to the effects of the Law of Diminishing Returns as we enter Year 8 of a bull market in stocks.

Most likely, as risk premiums increase, central banks will increasingly ease via more negative interest rates and more QE, and these moves will have a beneficial effect. However, I also believe that QE will be less and less effective because there is less “gas in the tank.” – Ray Dalio Bridgewater Associates  2/18/16

What’s Next?

And while QE will push asset prices somewhat higher, investors/savers will still want to save, lenders will still be cautious lenders, and cautious borrowers will remain cautious, so we will still have “pushing on a string.” As a result, Monetary Policy 3 will have to be directed at spenders more than at investors/savers. In other words, it will provide money to spenders and incentives for them to spend it.  Ray Dalio Bridgewater Associates

This latest rally saw investors chasing safe haven and dividend paying stocks like consumer staples and utilities. Investors are moving ahead but with caution. Other safe haven assets performed well in Q1 such as US Treasuries, Municipal bonds and Gold. We are also seeing investors maintain cash positions to levels not seen in years. We think that those are good signs. The fact that investors have sought and are seeking shelter will provide some cushion to any market tumble. Investors are preparing for another 2008 style crash. That, in essence, is why 2016 is NOT 2008.

Clients have been asking what metrics we are looking at as far as taking more equity risk. The 200 Day Moving Average (DMA) is the Maginot Line when it comes to seeing markets as bull markets or bear markets. Obviously, we would take more equity risk if we felt that we are in a bull market. Currently with the S&P 500 in a battle to take flight above its 200 DMA we are inclined to believe that we are still in a bear market and continue to hedge risk. If the bulls can get above and stay above the 200 DMA in the S&P 500 we would be more inclined to changing our mindset.

Oil’s bounce is alleviating pressure on borrowers and drillers but prices need to get back above $50 a barrel to really stop the pain. Currently, as we write West Texas Crude is below $40 a barrel. The selling of oil and oil related debt may be easing for now but the pain may only be delayed. High yield debt has seen money pour into that sector in the last month. Investors may be catching a falling knife there with more pain to come if oil cannot continue its recent rally.

We will continue to tactically change our asset allocation as the S&P 500 stays range bound between 1800-2100 and volatility continues its resurgence in 2016. We continue to hold bonds as it has been the most unloved of asset classes for the last several years as short sellers have been betting on rising interest rates and falling bond prices. In Q1 of 2016 bond returns have been in excess of 2% which is a very nice quarter for bonds. We see bonds as having value while the US 10 year yield is still north of 1.8% as we write while Japanese 10 year rates are less than zero. We feel that there is still adequate return to entice capital from around the world into US government bonds at 180 basis point spreads.

We cannot predict with 100% accuracy every move in the market but what we can do is try and profit by tactically allocating and hedging our portfolio in times of market stress to take advantage of market volatility. Investing is not a game of perfection but of managing the risk inside one’s portfolio. We do not jump in and jump out of the market wholesale. By divesting ourselves of overpriced assets and availing ourselves of opportunities when prices are low allows us to take advantage of the long term benefits that the math of compounding brings.

We still foresee 2016 as being a tactically driven year. We feel that changing our positions tactically with the ebb and flow of the market, decreasing the volatility of our portfolios by increasing positions in bonds and bond like instruments while also paying attention to companies that have pricing power like technology and health care will be the key to performance. Cash is also an important part of asset allocation because although it returns zero when risk premiums rise its value will be seen in its inherent call optionality and the opportunity set that it provides given lower asset prices.

I think we aspire less to foresee the future and more to be a great contingency planner… you can respond very fast to what’s happening because you thought through all the possibilities, – Lloyd  Blankfein CEO of Goldman Sachs

 

 

Warren Buffett’s Favorite Metric

Warren Buffett’s favorite metric for the market over the years has been the Ratio of US Market Capitalization to United States GDP. Here is a copy of it below from Ned Davis Research. Ned Davis Research is one of the best independent research outfits in the business and I have followed their insights for over 25 years.

What I find fascinating about this chart is the high levels of valuation since the mid 1990’s. I believe that this time period should be considered the Golden Age of Central banking. This was the Era of Greenspan and the Greenspan Put. Alan Greenspan was the Chairman of the US Federal Reserve Bank from 1987-2006. It was Greenspan that realized the power of central banking. Central bankers in previous eras did not have the tools at their disposal to manage monetary policy as effectively as Greenspan. It was the removal of the Gold Standard by Richard Nixon which allowed central bankers in the US to pull forward growth in order to manage downturns more effectively. Note however that since 1995, valuations in the market have exceeded the average levels consistently with the exception of the 2008 crash. That leaves us with some very big questions. How long can central bankers keep pulling forward returns? How long will markets continue to give higher than normal valuations to markets based on central bank policy? Ned Davis Research

Ned Davis March 2016 Mkt Cap GDP

The one era most like our current one is that the late 1936 – early 1937 period. Current high levels of Price Earnings ratios, and, historically low 10 Year yields combine in a disturbing stew now as they did in 1937. Coming out of the Great Depression Federal Reserve officials saw prices in the stock market build to uncomfortable levels and with inflation on the horizon began to raise interest rates. The first tightening in August 1936 did not hurt stock prices or the economy, as is typical.

The tightening of interest rates was made worse by currency wars as European nations chose to move in the opposite direction of US monetary policy. The world began to demand US Dollars and gold. As inflation picked up to 5% the Federal Reserve raised rates further in March of 1937 and again in May 1937. This tighter monetary policy reduced liquidity and sent bond and stock prices much tumbling. Stocks would bottom a year later down 50% from prior levels.

Given the high level of valuations in the Golden Age of Central Banking how will assets perform if the Federal Reserve wants to exit the policies that brought forth those valuations? Central bankers may find that The Golden Age of Central Banking may give way to the Roach Motel of Central Banking. They can get in but they cannot get out.  It’s all about how markets react to the second and third rate hikes.

In our last blog post we mentioned the key levels for the market and now we are there. The bulls did not have much trouble surmounting the 1940 level but 2000 may prove more difficult.

The next level for the bulls is the 2000 number on the S&P 500 and then 2020. We have a confluence of moving averages and resistance zones to overcome here but the bulls have the bears on the run and shorts are covering as they feel the pain.  The risk at the moment is skewed to the downside as we have come very far very fast since the lows of 1812 in mid February. The market is extremely overbought and needs to rest. Let’s see if the bears can push back the bulls. Markets are looking for central bank intervention and if not from China this weekend then perhaps the ECB next week. Shorts are feeling the pain and the bulls may have their hearts set on 2100 on the S&P

Clients have been asking what metrics we are looking at as far as taking more equity risk. The 200 Day Moving Average (DMA) is the Maginot Line when it comes to seeing markets as bull markets or bear markets. Obviously, we would take more equity risk if we felt that we are in a bull market. Currently with the S&P 500 below its 200 DMA we are inclined to believe that we are in a bear market and continue to hedge risk. Let’s see if the bulls can get above and stay above the 200 DMA.

Oil’s bounce is alleviating pressure on borrowers and drillers but prices need to get back above $50 a barrel to really stop the pain. Forced selling of oil and oil related debt may be easing for now but the pain may only be delayed. High yield debt has seen money pour into that sector in the last week. Investors may be catching a falling knife there with more pain to come.

In our last blog post we asked you to keep an eye on gold. We feel that foreign investors could find solace here as the games of currency wars and negative interest rates heat up. That continues to be the case. Gold has been the star of 2016 and this week was no different. The yellow metal may be due for a rest but it might a short one. Negative interest rates in Europe are helping as are the concurrent currency wars between Japan, China, the US and Europe. Hold on tight and keep an eye on gold. Ray Dalio was at the University of Texas this week telling retail investors that they should consider holding 5% of their assets in gold. Look at Sprott Physical Gold Trust (PHYS) ETF and SPDR Gold Trust (GLD) ETF if you are determined to hold gold in your portfolio. PHYS has had better performance this year than GLD.

Not recommendation just information. Investing is not a game of perfect.  It is a game of probabilities.

 

I think we aspire less to foresee the future and more to be a great contingency planner… you can respond very fast to what’s happening because you thought through all the possibilities, – Lloyd  Blankfein

To learn more about us and Blackthorn Asset Management LLC visit our website at www.BlackthornAsset.com .

A pessimist sees the difficulty in every opportunity; an optimist sees the opportunity in every difficulty. – Winston Churchill

Disclosure: This blog is informational and is not a recommendation to buy or sell anything. If you are thinking about investing consider the risk. Everyone’s financial situation is different. Consult your financial advisor.

Investors Spooky October

While October has traditionally been a spooky month for investors the only thing scaring investors this October was the huge gains in the stock market. October 2015 will go down as the best performing month for the S&P 500 in four years.  I think that we all enjoyed the ride back up in October. The S&P 500 rallied 8.3% and followed through with more gains today to get the S&P 500 into the plus column for 2015. Those gains would be nice gains for an entire year – never mind a month! Whenever we get to thinking how much we have gained we cannot help but to contemplate the downside. We must always be on guard to temper our greed/ego just as much as we would concentrate on opportunity when fear strikes.

Be fearful when others are greedy and greedy when others are fearful. – Warren Buffett

While the S&P 500 has moved back into the trading range that it occupied in the first half of 2015 it that would indicate that, at the very least, the market is due for a breather. We believe that the current upside in the market is therefore limited and that a pullback is not only likely but healthy for continued market gains. We are concerned about the lag in Small Cap stocks and what that may indicate for the market in the near term. We saw an exciting rise in Large Cap indexes in October but their Small Cap brethren have not kept pace. Usually, that signals a weakness in the market as investors flock to the relative safety that Large Cap stocks provide rather than seek out the higher risk/reward paradigm of small cap growth. This anomaly could also indicate a near term change in direction of stocks.

The current general consensus is for the market to make further gains as the traditional Santa Claus rally appears into the end of the year. We believe that the October rally has brought forward much of those gains and further gains into the end of the year will be muted. We would expect the market to take a breather and settle into a trading range as we close out 2015. It is a little early to foresee what 2016 holds in store but given the volatility that we have since August of this year we believe that 2016 will continue in the same vein and be a volatile year. While higher volatility does not indicate a top for the market higher volatility does tend to appear in the last act of an aging bull market. We could be seeing a market that compares in time to the 1999-2000 market when the Federal Reserve was preparing to raise interest rates.  We believe that 2016’s returns will be +/- 20% for the year. Not very exact or comforting but it does allow us to plan. That plan would include more and larger tactical moves than we have made in the recent past.

“What you saw in the third quarter of this year could well have been a harbinger of things to come over the next year or two,” Bruce Karsh, CIO and cochairman of Oaktree Capital Group said October 29 after the company reported earnings. 

We cannot predict with 100% accuracy every move in the market but what we can do is try and profit by tactically allocating and hedging our portfolio in times of market stress to take advantage of market volatility. Investing is not a game of perfection but of managing the risk inside one’s portfolio. We do not jump in and jump out of the market wholesale. By divesting ourselves of overpriced assets and availing ourselves of opportunities when prices are low allows us to take advantage of the long term benefits that the math of compounding brings.

I think we aspire less to foresee the future and more to be a great contingency planner… you can respond very fast to what’s happening because you thought through all the possibilities, – Lloyd  Blankfein

To learn more about us and Blackthorn Asset Management LLC visit our website at www.BlackthornAsset.com .

A pessimist sees the difficulty in every opportunity; an optimist sees the opportunity in every difficulty. – Winston Churchill

Disclosure: This blog is informational and is not a recommendation to buy or sell anything. If you are thinking about investing consider the risk. Everyone’s financial situation is different. Consult your financial advisor.

Waiting on the Fat Pitch

Geopolitics continue to call the tune as markets move on every twitter feed out of the Ukraine. The movements of troops are moving the troops on Wall Street as nervous investors look to stay ahead of the machination of politicians in the eastern bloc. This is the nervous time of year after all. Investors are very cognizant that summer markets are very thin and can move on very little news as traders sun themselves on beaches before the kids head back to school. Back to school usually brings some sort of stress test as Se[ptmeber and October have a history of ugly turns in the market. It is no wonder we are seeing investors such as George Soros and David Tepper hedge long positions in the stock market. With valuations at such high levels, troops at high alert and investors highly anxious about what the fall may bring it may be a prudent strategy to continue to build investing defenses. Even Warren Buffet who hates carrying substantial amounts of cash on his books is currently at his highest level of cash in over 40 years.   http://www.bloomberg.com/news/2014-08-04/buffett-waits-on-fat-pitch-as-cash-hoard-tops-50-billion.html

One of Mr. Buffett’s investing axioms is, much like a baseball batter with unlimited strikes might do, is to wait for the fat pitch. With over $50 billion on hand at Buffett’s Berkshire Hathaway that is one fat pitch indeed. Below by way of dshort.com comes Buffett’s favorite market indicator – Market Capitalization to GDP. As a signal the market is overbought when the indicator breaks 100% and is oversold when it goes below 60%. We are currently at 126% of GDP. Markets can advance farther than one thinks but this indicator is certainly flashing a yellow caution light.

 

The above chart, also from dshort.com, is the Q Ratio. The Q Ratio was developed by James Tobin, Nobel Laureate from Yale University. The Q Ratio measures the combined market value of companies to their replacement cost. A ratio below one indicates that the value of the company’s stock is cheaper than replacement cost while a ratio higher than one indicates that the company’s stock value is higher than the replacement cost. From this one can see that markets and investors don’t listen to yellow caution lights and sometimes just sail on through. The Internet Bubble of 2000 pushed right on through the highest levels of Q Ration ever recorded. Flashing caution at over 1.0 this metric currently stands at 1.17. High levels but one does not know when a bubble breaks.

Having aid that we do believe that the Federal Reserve’s action of continued monetary policy have induced these high levels of asset prices. Any further reduction in monetary heroin may induce less than euphoric feelings from the marketplace. In July the reduced asset purchases began to have an effect on markets and those purchases are planned to cease in October of this year. We continue to expect volatility to increase into that time frame and prepare for the opportunities that may rise from the change in monetary policy.

Equity markets have seen increased volatility, which from our perspective, limits upside potential in markets. Equity markets have seen higher upside since 2008 when markets are stable and not volatile. We believe that this volatility will continue into the fall of 2014. The Ukrainian situation and Portuguese banking crisis presented volatility and a selloff of risk in equity markets. That extended selloff was afforded a bounce in prices this past week. That bounce may have run its course. Friday’s action in the market provided clues that the bulls short run has ended as bears took control in the afternoon on Friday at critical resistance points. This week may be critical in the future near term course of the market as everyone awaits Janet Yellen’s Jackson Hole speech on Friday.

We continue to use small caps as our map while US Treasuries and Gold continue to be our risk temperature gauge. For the moment 1960/68 is key resistance in the S&P 500. If the bulls can leap above this level the run can continue. On the downside, the Russell 2000 needs to hold 1100.  Also keep an eye on the VIX index. As it spikes the Fed may try to calm fears.

I think we aspire less to foresee the future and more to be a great contingency planner… you can respond very fast to what’s happening because you thought through all the possibilities, – Lloyd  Blankfein

To learn more about us and Blackthorn Asset Management LLC visit our website at www.BlackthornAsset.com .

A pessimist sees the difficulty in every opportunity; an optimist sees the opportunity in every difficulty. – Winston Churchill

Disclosure: This blog is informational and is not a recommendation to buy or sell anything. If you are thinking about investing consider the risk. Everyone’s financial situation is different. Consult your financial advisor.

Published in: on August 16, 2014 at 8:46 am  Leave a Comment  
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Ghosts of Irrational Exuberance

Dallas Federal Reserve President Richard Fisher was in Mexico City this week and spoke with his usual candor on Fed policy, asset pricing and the ineptitude of our current government. Fisher has an interesting vantage point on our economy and fiscal/monetary policy and his frankness is refreshing. In his speech Fisher warns that the Fed’s bond buying may be distorting markets and that some indicators like price to forward earnings ratios, margin debt and market capitalization to GDP have risen to levels not seen since the dot com boom of the late 1990’s.

I fear that we are feeding imbalances similar to those that played a role in the run-up to the financial crisis. With its massive asset purchases, the Fed is distorting financial markets and creating incentives for managers and market players to take increasing risk, some of which may result in tears. And all this is happening in uncharted territory. We have aided creation of massive excess bank reserves without a clear plan for how to drain them when the time comes. And there is the challenge of doing so while keeping inflation expectations stable.

 We must monitor these indicators very carefully so as to ensure that the ghost of ‘irrational exuberance’ does not haunt us again.’

 http://dallasfed.org/news/speeches/fisher/2014/fs140305.cfm

On the subject of margin debt comes these stats from Jason Goepfert of SentimenTrader by way of Arthur Cashin.

 The latest margin debt figures were released for January showing another uptick in debt and decrease in the net worth of investors. The “available cash” for investors to withdraw is now negative $159 billion, another record low. As a percentage of the market cap equities of all US equities, it amounts to -0.75%, tied with February 2000 for the most extreme figure since June of 1987.

Our attention turned to bonds when it was reported by Bloomberg that Warren Buffett has taken his bond holdings down to their lowest level in over a decade. Buffett, never one to hold an overweight in bonds has lowered his bond holdings at his insurance units to just 14%. Buffett typically holds between 20-25% of his insurance units holdings in bonds. As Fisher said in his speech in Mexico City this week, all asset valuations are getting distorted. The only question is which is least overvalued or do you hold significant amounts of cash earning very little or nothing. Buffett’s cash position has risen to almost 26% of the assets at his insurance units. Buffett is overweight cash, earning very little, and he is not happy about it either.

http://www.bloomberg.com/news/2014-03-06/buffett-cuts-bond-allocation-as-berkshire-warns-on-yields.html

Insiders at some of the largest and most successful money management firms are moving money to the sidelines in their personal accounts. Executives at Carlyle and Oaktree sold $250MM and $300MM respectively of their personal holdings. Follow the smart money.

 It seems reasonable to be prudent here as the bull that started in March of 2009 is now 5 years old. This bull is now the 6th longest on record and the 4th best performing. Could we be in a bubble like that of 1997-1999? It is possible with the Fed still pouring money in. My philosophy here is to keep our hands in the game, find the cleanest dirty shirt and keep your options open if things begin to turn south. Cash pays nothing but we feel that we are in good company with Buffett as he is also underweight bonds and overweight cash.

 To learn more about us and Blackthorn Asset Management LLC visit our website at www.BlackthornAsset.com .

A pessimist sees the difficulty in every opportunity; an optimist sees the opportunity in every difficulty. – Winston Churchill

Disclosure: This blog is informational and is not a recommendation to buy or sell anything. If you are thinking about investing consider the risk. Everyone’s financial situation is different. Consult your financial advisor.

Sage Advice on Investing

 Howard Marks was interviewed by a Swiss publication titled Swiss Finanz und Wirtschaft late last week. Here are some great tidbits that caught our eye from a Master of Investing on the role of emotions.

 I’ve been in this business for over forty-five years now, so I’ve had a lot of experience.  In addition, I am not a very emotional person. In fact, almost all the great investors I know are unemotional. If you’re emotional then you’ll buy at the top when everybody is euphoric and prices are high. Also, you’ll sell at the bottom when everybody is depressed and prices are low. You’ll be like everybody else and you will always do the wrong thing at the extremes. Therefore, unemotionalism is one of the most important criteria for being a successful investor. And if you can’t be unemotional you should not invest your own money, period. Most great investors practice something called contrarianism. It consists of doing the right thing at the extremes which is the contrary of what everybody else is doing. So unemotionalism is one of the basic requirements for contrarianism.

There are two main things to watch: valuation and behavior. A great thing about investing is that you have historic valuation standards. You should be aware of them, but you shouldn’t be a slave to them.  You can compare the current P/E ratio to historic standards and see that the current P/E ratio is about fair relative to history. So valuations are moderate to a little expensive in most areas. Looking at investor behavior, you can ask yourself: Is everybody at the club, on the train or in the office talking about stocks? Is everybody having fun and making easy money? Is everybody saying even though the market has doubled, I’m going to put more money in? Is every deal sold out? Is every fund sold out? In other words: Is the party rolling? And if that’s the case, then you should be very cautious. It’s like Warren Buffett says in one of my favorite quotes: The less prudence with which others conduct their affairs, the greater the prudence with which we must conduct our own affairs.

 It must be that time of the year as investing masters are out and about giving sage advice. Warren Buffett gave a preview of his Annual Letter this week to his good friend Carol Loomis at Fortune magazine and he also warns about the effect of emotions on investing. Here is an excerpt.

In 1986, I purchased a 400-acre farm, located 50 miles north of Omaha, from the FDIC. It cost me $280,000, considerably less than what a failed bank had lent against the farm a few years earlier. I knew nothing about operating a farm. But I have a son who loves farming, and I learned from him both how many bushels of corn and soybeans the farm would produce and what the operating expenses would be. From these estimates, I calculated the normalized return from the farm to then be about 10%. I also thought it was likely that productivity would improve over time and that crop prices would move higher as well. Both expectations proved out.

I needed no unusual knowledge or intelligence to conclude that the investment had no downside and potentially had substantial upside. There would, of course, be the occasional bad crop, and prices would sometimes disappoint. But so what? There would be some unusually good years as well, and I would never be under any pressure to sell the property. Now, 28 years later, the farm has tripled its earnings and is worth five times or more what I paid. I still know nothing about farming and recently made just my second visit to the farm.

 I thought only of what the properties would produce and cared not at all about their daily valuations. Games are won by players who focus on the playing field — not by those whose eyes are glued to the scoreboard. If you can enjoy Saturdays and Sundays without looking at stock prices, give it a try on weekdays.

http://finance.fortune.cnn.com/2014/02/24/warren-buffett-berkshire-letter/

The bulls are still in control although there does seem to be some doubt due to their failure to launch. Friday’s action had the bulls squarely in charge even in light of poor economic numbers. The bulls had the market plus 150 before reports came in that Russia had invaded the Ukraine sending stocks careening to their lows of the day and negative on the session. The market rebounded to up 40 points on the Dow but I would have to say it was not a real confidence builder for the bulls. The bull’s advances, having been repelled 4 times at the old high and now punching through only to rapidly fall back leaves us in doubt about the bull’s ability to maintain the new high. Keep an eye on the new high. Let’s see if the bulls can maintain their ground. Bonds continue to perform well as QE is wound down.

 To learn more about us and Blackthorn Asset Management LLC visit our website at www.BlackthornAsset.com .

A pessimist sees the difficulty in every opportunity; an optimist sees the opportunity in every difficulty. – Winston Churchill

Disclosure: This blog is informational and is not a recommendation to buy or sell anything. If you are thinking about investing consider the risk. Everyone’s financial situation is different. Consult your financial advisor.

Be Prepared

As the market rallies cracks are beginning to show in the internals of the market. Arthur Cashin points out this week that the old saw that the public (weak hands) control the market in the morning and the pros take control in the afternoon may be a glaring admission of a tempering of risk by market pros. The strongest time of the day recently has been the first half hour of trading. The last hour has been a big loser. It appears market pros are lightening up in the last hour of trading.  Here is the data by way of Arthur and the Bespoke investment Group.

 A Study In Time – The nice folks over at Bespoke Investment Group have rummaged through their voluminous database to reveal that the market recently has developed two personalities – an opening one and a closing one.  Here, courtesy of The Kirk Report, is a bit of what they said:

 Had you bought the S&P 500 at the close and sold at 10 AM ET on the next trading day, you would be up 7.97% over the last six months. This is by far the best time of the day for the market. From 10 AM to 3 PM, the market has seen gains, but they have been minimal. Had you bought at 3 PM and sold at the close, however, you would be down 4.52%, which is a big loss in a market that is up 10% over the last six months. We’ve talked about the “Smart Money Indicator” in the past, which is a market axiom that says the “dumb money, ” or retail money, trades at the open while the “smart money,” or institutional money, trades at the close. If this is the case, the retail investor has been bidding this market higher, while the institutional money has been fighting it the entire way up. The fact that individual investor sentiment is hardly bullish would contradict this theory, however, but either way, it’s an interesting trend, and it’s one to keep in mind when you’re trading this market over the last two weeks of 2013.

Next year is Year II in the US Presidential Cycle. The second year of the US Presidential Cycle tends to be the weakest of the four years as monetary and fiscal policy begins to tighten. Year II of the cycle has shown a tendency to have a midyear setback to the market and then a rally to finish up on the year. Year III (which would be 2015) is the strongest year of the cycle.  Most market participants that I read and respect are predicting an up year for 2014 with between an 8-12% return and a midyear correction on the order of 10% or even 20%. Seasonality did not work so well in 2013 as the Federal Reserve’s QE policy dictated market direction. That policy is now looking to be wound down. How will that affect markets and seasonality? Will it be a return to form?

The bond market is a dangerous place to be in most investors minds. Our response has been to underweight our bond allocation as well as shorten duration to the 5-7 year range in order to account for the risk of rising interest rates. We have a chart here from Citigroup Foreign Exchange Technicals group that shows, counter intuitively, that Quantitative Easing leads to higher rates during QE and that the end of QE brings lower rates on the US Treasury 10 year. Citi’s thesis is that more QE leads to a rush into higher risk assets and the dumping of bonds to the government as the buyer. The end of QE brings money back into safer assets like the US 10 year as it flows out of stocks and hot money destinations like emerging markets. Keep an eye on the 10 year and emerging markets like Turkey and Malaysia.

 

The market was relieved this week to have the Federal Reserve start to remove the band aid that is QE. 2014 is going to be a very interesting year (as they all seem to be lately).  We are cautious as everyone seems to be buying stocks and selling bonds. The contrarian in us continues to question the moves of the broader investing public. We simply attempt to be fearful when others are greedy and to be greedy only when others are fearful. – Warren Buffett

The winding down of QE could bring some bumps in the road. While we look for rates to go higher in time the end of QE may force rates lower, ironically, as investors come back to less risky assets. The market is reaching all time highs with all time high profit margins. Something else to watch out for in 2014 is a reversion to the mean in profit margins which could lead to sky high valuations in the stock market. We question whether QE has led corporate executives, whose pay is directly tied to stock performance, to manage even more to what Wall Street’s expectations. Get more out of less. Borrow to pay higher dividends and buy back stock. Do not invest in plants, equipment, and technology and hire more workers. Could allowing the stock market to fall give executives the excuse to invest more in plants and workers? Thereby improving the economy. I have always surmised that the ending of QE would be far more difficult than beginning it. The handoff could easily cause some major bumps in the road. We do believe that this bull is long in the tooth and has surpassed the average age of a bull market. The slow winding down of QE may allow for further gains in the market but valuations are stretched. The sideways move in the market that is going on 14 years now has produced a major consolidation period much akin to the 1966-82 period. Most consolidation phases consist of 3 major selloffs. We have had two and are due for a third. If those bumps in the road come due to recession or QE handoff this may produce one of the great buying opportunities of our generation.

Our companies are the most financially prepared and most productively operated they have been at any time during the nearly four decades since I graduated from business school. – Richard Fisher of the Dallas Fed on  12/9/13.

The above quote is from Dallas Fed Governor (and voting member in 2014) Richard Fisher who has long advocated that the current policy of QE is having dangerous unintended effects and diminishing benefits. I keep reading the quote and find myself stuck on one word. The word is prepared. Prepared for what Governor? I surmise that they are prepared, in his mind, for an end to the emergency policies of the Federal Reserve and the inevitable bumps in the road associated with an end to those policies. Be prepared.

The turn in the calendar in 2014 may entice managers to raise cash levels early on in the year as to not suffer any outsized losses at the start of 2014. A large loss early in 2014 would make for a tough slog all year. However, missing out on some upside early on in the New Year would be far easier to make up for on the performance side. Always keep an eye on the calendar. Seminal changes tend to take place at the turn of the year.

Happy Holidays and Merry Christmas!!

To learn more about us and Blackthorn Asset Management LLC visit our website at www.BlackthornAsset.com .

A pessimist sees the difficulty in every opportunity; an optimist sees the opportunity in every difficulty. – Winston Churchill

I learned that courage was not the absence of fear, but the triumph over it. The brave man is not he who does not feel afraid, but he who conquers that fear. – Nelson Mandela

Disclosure: This blog is informational and is not a recommendation to buy or sell anything. If you are thinking about investing consider the risk. Everyone’s financial situation is different. Consult your financial advisor.

Published in: on December 21, 2013 at 9:19 am  Leave a Comment  
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Afraid To Taper?

Just when I think I’m out – they pull me right back in. – Ben Bernanke

We suppose that you know that the above mentioned quote should not be attributed to Ben Bernanke but to one Michael Corleone. The Fed Chairman must have felt this way though as the FOMC decided not to pursue any taper at all at the September meeting this week. Here is another quote – from Deutsche Bank this time- that sums up the Fed’s conundrum.

“…the path of tapering is going to be tough because every time the market thinks they are going to taper, yields will likely rise and conditions will tighten” – Deutsche Bank

It is interesting to note that the Fed passed on a free option to Taper their purchases. The question is – Why?  We have postulated that the level on the 3% level on the US 10 year Treasury is the most important metric to watch. As the level was approached due to Taper Talk the rate of mortgage originations began to decline rapidly. Layoffs in the mortgage departments at JPMorgan and Wells Fargo also certainly caught the good doctor’s eye.  Is the 3% level the new Maginot Line?

The Fed’s new transparency has the market on edge. The Fed led the market to tapering but didn’t make it drink. The street is now questioning leadership and the Fed may not be able to jawbone the market as the street loses confidence. The market feels as though it has been lied to and the Fed now has a credibility problem. So much for trying to be more transparent.

Will the market take off now that the Fed is monetizing even greater amounts of the government’s debt?  Is the Fed afraid to taper? Is the economy that weak? We do know that they are blowing an even bigger bubble that will at some point break. Remember central banks don’t create growth they only pull demand forward much as they have pulled market returns forward. Does it make sense that the market is at all time highs if the economy is so weak that the Fed cannot withdraw? The Fed has pulled market returns forward by pushing investors into riskier assets. Markets will reprice at some point.

Asset prices are getting bubbly again as investors from Cooperman to Druckenmiller to Buffett and Witmer are of the opinion that asset values are fully priced.  Equity prices have risen due to the expansion of P/E. Simply stated, earnings have not risen but investors continue to pay higher prices for the same $1 of earnings. Should the amount that investors are paying for $1 of corporate earnings be above the longer term averages if the economy is not growing? More and more investors are reaching further and further out on the limb to grab the fruit.

Market technicians say that market spikes – like the one on Wednesday – are followed by a couple of days of follow through buying but then produce less than stellar returns over the next two months. The debt ceiling talk may also help produce that result. However, any market pullback should be met with buyers as the longer term bull is still intact. That is until the Fed withdraws from the battle field.

To learn more about us and Blackthorn Asset Management LLC visit our website at www.BlackthornAsset.com .

A pessimist sees the difficulty in every opportunity; an optimist sees the opportunity in every difficulty. – Winston Churchill

Disclosure: This blog is informational and is not a recommendation to buy or sell anything. If you are thinking about investing consider the risk. Everyone’s financial situation is different. Consult your financial advisor.

Published in: on September 20, 2013 at 10:37 am  Leave a Comment  
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